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Economist Interviews from the 39th Annual
Federal Reserve Bank of St. Louis Fall Conference
Oct. 9-10, 2014


Message from the President


James Bullard
President and CEO, Federal Reserve Bank of St. Louis


Christopher J. Waller
Senior Vice President and Research Director, Federal Reserve Bank of St. Louis


Message from the Research Director

Foreword from the Conference Organizers
William Dupor and Yongseok Shin
Federal Reserve Bank of St. Louis


Conference Volume Description


Interview with Fernando Alvarez
University of Chicago


Interview with Mark Bils
University of Rochester


Interview with V.V. Chari
University of Minnesota



“Mandatory Disclosure and Financial Contagion”

“Resurrecting the Role of the Product Market Wedge in Recessions”

“On the Optimality of Financial Repression”

“Spatial Variation in Higher Education Financing and the Supply of College Graduates”
Interview with John Kennan
University of Wisconsin-Madison

“Competition and Bank Opacity”
Interview with Ross Levine
University of California, Berkeley

“Demand Stimulus and Inflation: Empirical Evidence”


Interview with Iourii Manovskii
University of Pennsylvania


Interview with Giuseppe Moscarini
Yale University



“Did the Job Ladder Fail after the Great Recession?”

“The New Full-Time Employment Taxes”
Interview with Casey Mulligan
University of Chicago

“What Shifts the Beveridge Curve? Recruitment Effort and Financial Shocks”
Interview with Gianluca Violante
New York University

At the Federal Reserve Bank of St. Louis, we have long tried
to provide perspectives on whether the policies adopted in
the past still serve us well today and whether recent developments at the frontier of research can be fruitfully applied to
improve policy. This agenda has become especially important in the past few years, as the Federal Reserve and central
banks around the world have struggled to devise appropriate
policy responses to the current macroeconomic situation.
In polite economist society, there has long been a distinction
between what is known as “frontier” research and what is
sometimes called “policy” research. In my view, this has
been and continues to be a false dichotomy. There is no such
distinction: “Policy” and “frontier” research are two sides of
the same coin. We need to understand both how fundamental mechanisms in the economy operate as well as how current data can be interpreted in terms of fundamental theory.
In short, advanced economic theory has to be made more
relevant for actual policy, and actual policy has to understand and embrace the sometimes difficult ideas advanced
in the theoretical world. The St. Louis Fed has long been a
leader in supporting research at the intersection of economic
theory and economic policy.


At our 2014 fall conference, we were fortunate to have an
outstanding group of speakers whose research expands our
understanding of key contemporary issues in macroeconomics. The conference agenda included papers on labor markets
and education, banking regulation issues, and other topics.
The St. Louis Fed was proud to provide this forum for discussion and analysis of the leading issues of the day.
In addition to finding ways to connect the research world
with the policy world, the St. Louis Fed strives to connect
academic research with a nonacademic audience. Our goal is
to explain in lay terms why the research is important, what
implications it has for policy and what it means for people
and the economy overall.
This volume brings the main findings of the research presented during the conference to a wider audience. We hope
that you find the material informative and that it will serve
as a resource on important macroeconomic and policy issues.
James Bullard
President and CEO
Federal Reserve Bank of St. Louis

The Research division of the Federal Reserve Bank of St.
Louis has long been renowned for its cutting-edge research,
policy analysis and provision of economic information to the
public. This tradition dates back to the 1960s, when Homer
Jones was the director of the Bank’s Research division. At
that time, the St. Louis Fed took a very contrarian stance on
how monetary policy should be conducted and backed that
stance with top-flight economic research.
We have found that the best policy advice comes from
economists who work at the frontier of economic thinking. Academic economists are often vocal in their views
about policy and are willing to critique actions taken by the
Federal Open Market Committee, the main policymaking
body of the Federal Reserve System. To evaluate arguments
of academic critics and make use of good ideas and research
for policy, the Fed must have economists who work at the
frontier of knowledge. Fed economists must be able to
explain their own views in a rigorous way, as well as explain
why an alternative claim about policy is suspect. A healthy
competition of ideas allows the best theories and policies to
win in the end.

Academic research is valuable because the thinking about
economic issues is unrestricted. It is proactive in that it often
focuses on interesting issues long before they come to the
attention of policymakers.
Academic research is rigorously vetted before publication in
peer-reviewed journals. It is forged in the fires of debate and
criticism. Academic research also takes the form of program
evaluation (economic autopsies) of major economic events.
It can take years to analyze and understand what happened
and what policies or regulations need to be changed.
At the St. Louis Fed, we continually look for ways to connect
frontier research with policy. Our annual fall conference,
which brings together leading academics and economists,
does just that. The discussions that follow highlight some
of the key contributions of the papers presented at the 2014
fall conference.
Christopher J. Waller
Senior Vice President and Research Director
Federal Reserve Bank of St. Louis


Every year, two economists from the Research division of the
Federal Reserve Bank of St. Louis are selected to organize
the Bank’s annual research conference. The privilege was
ours for the 39th Annual Federal Reserve Bank of St. Louis
Fall Conference. Of course, a conference of this magnitude
doesn’t come about through the work of only two people.
While we may have had the distinction of, as St. Louis Fed
President James Bullard noted in his opening remarks of the
conference, “putting this provocative program together,” we
are grateful for the numerous Bank employees who worked
to make this conference happen.
The rich tradition of this conference began when the first
one was held on Nov. 30, 1976. It was titled “Financing
Economic Growth: The Problem of Capital Formation”
and considered the problems of generating sufficient flows
of saving and investment to finance economic growth and
development in the future.
Since then, the annual conference has continued to feature
the latest in policy and frontier research. This year’s conference was highlighted by yet another distinguished group of
speakers. Specifically, this year’s speakers presented papers:
• Measuring market frictions and their role in explaining
the “labor wedge”
• Assessing the ability of demand stimulus to increase
• Gauging the Affordable Care Act’s effect on households’
incentives and work schedule decisions
• Discussing job-to-job flow patterns after the Great
Recession and the effect on unemployment


• Measuring financial shocks’ effect on matching idle labor
with idle jobs
• Studying the impact of states’ higher education subsidies
on young people’s education and migration decisions
• Discovering circumstances when mandatory disclosure
requirements on banks are beneficial
• Discussing regulatory reforms to promote competition
and gain greater voluntary transparency in the
banking sector
• Measuring whether it is ever beneficial to require banks to
hold more than their otherwise preferred level of government bonds
One of the St. Louis Fed’s goals is to make economic data
and research available to a broad audience. This conference
volume, in which our speakers describe their work in layman’s terms, follows in that tradition.
We thank you for your interest in the 2014 fall conference
and look forward to the 40th conference in 2015.
William Dupor
Assistant Vice President
Federal Reserve Bank of St. Louis
Yongseok Shin
Research Fellow
Federal Reserve Bank of St. Louis

The Federal Reserve Bank of St. Louis hosted its 39th Annual Fall
Conference on Oct. 9–10, 2014. David Andolfatto sat down with each
of the conference presenters and discussed their work in plain English.
The content in this conference volume is based on those interviews. All
interviews have been edited for clarity and length.
For the full conference agenda, please see
The views expressed in this volume are those of the individuals presenting them and do not necessarily
reflect the views of the Federal Reserve Bank of St. Louis or the Federal Reserve System.


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

Professor of Economics, University of Chicago
Paper: “Mandatory Disclosure and Financial Contagion”
(with Gadi Barlevy)

Why don’t you tell us a little bit about the question that
you’re addressing in the paper?

they talked about some of the advantages. But what we want
to think about is: If they are so good, why don’t banks do it
by themselves?

The general question is to study one of the aspects of the
stress tests. The stress test is one of the policy tools now used
by central banks, mainly the European Central Bank (ECB)
and the Federal Reserve, to analyze how banks will fare in
differing scenarios, and then they make this information
public. Stress tests have other aspects, but in our paper we
mostly analyze that feature.

The idea is not that they are doing something to, you know,
get banks doing something bad. It’s just they are doing something that in fact will help banks. It will help everybody.

Are these stress tests something new? Or is this something
that has been done in history? Is it something that’s come
about because of the financial crisis?
The form of the stress test has changed more than a little bit
because of the financial crisis. Obviously, there has always
been supervision from central banks over commercial banks
and other banking institutions. But there has been a change
to make the information public, which is not something that
we have seen before. That’s the aspect that we tried to study.
So regulatory bodies have regularly stress tested banks
before to see how resilient they might be under different
alternative financial stress conditions. But what’s new,
you’re saying here, is that they’re making the information
public to the community? And you’re interested in
whether this is a good idea?
Exactly. So under what conditions is this a good idea from a
public policy perspective, precisely? As you mentioned with
your question, this is new. It happened in the financial crisis.
And you see it in the academia and in the policy-making
circles, like some of [former Federal Reserve Chairman Ben]
Bernanke’s speeches and obviously his influence during his
tenure on conducting the stress test, but also in evaluating
it afterwards in the ECB. So you see it in the public policy
arena, in the academia, and also in some of the practitioners,


So, from their perspective, if they are so good, why don’t they
do it by themselves? And also, if they are so good now, is it
like somebody just discovered that now they are good and
before people didn’t realize? Or is it because of the financial crisis that these are special circumstances whether they
are good or not? So then our paper—like most academic
papers—takes a stylized version of the world and tried to
answer these questions in that stylized version.
There are also conventional reasons for why this type of
information is not disclosed publicly, perhaps the stigma
that such a disclosure might impinge on a particular bank
that’s identified as being weak. What do you have to say
about that?
We studied a setup where sometimes it’s a good idea and
sometimes it’s a bad idea, but we get a bit more precise.
The times in which it’s a good idea is when there’s a lot of
contagion in the sense that the fate of a particular bank is
not determined that much by how these banks operate, but
by how the whole network of banks operate. For instance:
During the crisis, you had a market freeze, not so much
because there’s a large loss—maybe their losses are not
huge—but we don’t know where they are. So the image that
we have is there are some bad apples, but we don’t know
where the bad apples are.
So the location of the risk is not known, and this
potentially poisons the whole barrel.
Exactly. So everybody doesn’t trust everybody else. The interesting aspect is that these are situations in which individual

“The idea for policymakers and investors is
that if a lot of people disclose information,
you could try to find the architecture of
the financial network and really see where
the bad apples lie.”

banks may not want to show that they themselves don’t have
the bad apples. But if they’re all encouraged to do it, then
you could get in a situation that is better for everybody and
unfreeze the markets.
Under these conditions, we should observe that
individual banks express voluntary desire to participate
in the program.
If you know that the other banks do it, you are fine to do it.
But if you’re the only one, you may not want to do it. And I
think the intuition is relatively simple.
Let’s say that it has some cost to disclose this information and
some benefits, such as showing to potential investors in the
bank or other creditors that I’ve survived the stress test. But
this also benefits you if, say, you’re another bank, I owe you
some money, and now you know that I’m solvent. And then
the idea is that if you are all forced to do it, then the social
benefits will be internalized.
Now, in a situation in which we don’t trade that much, so we
don’t have these interlocked portfolios and your fate isn’t so
dependent on mine, then this wouldn’t be an issue. In normal
circumstances—circumstances where there’s not much what
we call contagion—then the private and social benefits would
be aligned.
Your paper makes it very clear when and when not this
type of policy of mandatory disclosure of stress test
results is a good idea socially, and you mentioned that
it all hinges on the degree of what you call potential
contagion, the extent to which banks are interlocked.
It’s the idea that maybe Lehman [Brothers] didn’t have anything bad themselves. But then if someone else owes money
to Lehman, I don’t want to lend to Lehman.

Operationally, can we observe this interlocking set of
claims? Is this something we can see?
The idea for policymakers and investors is that if a lot of
people disclose information, you could try to find the architecture of the financial network and really see where the bad
apples lie. Now obviously, it will always be imperfect. But the
idea is that one person, only one bank, disclosing information
will give very little information about the whole network,
while a lot of banks disclosing information will help a lot.
So it will be imperfect, but if you think about clearinghouses
and these type of financial arrangements, they’re all like, “I’m
trading with you, but do I have to worry about your trading
counterparties?” This is an issue that financial institutions
think about a lot. One part of the contribution of this is that
maybe it’s forcing them to have to account for the social benefit and not just the private benefits of disclosing information.
On the whole then, you’d say your paper is generally
supportive of the program, the stress tests?
Yes. In particular, Bernanke in the public policy arena or
Gary Gorton in the academia pointed out that the freeze of
markets in 2008 looked like, “I don’t want to trade because
I don’t know whether the other party will be able to pay
me.” These may be the type of situations for which this is
When was the first stress test implemented?
There have been similar types of tests elsewhere, and then
there’s also the International Monetary Fund (IMF) now
trying to encourage [them] more broadly, but mostly they are
in the ECB and in the U.S. It wasn’t at the very beginning
of the financial crisis, but in 2009 there were two waves. The
first one had disclosure of this information, and this was the
first time that it has happened.
And I think I recall reading that Bernanke attributed a
calming of the financial markets because of the outcome
of the information. Do you share that opinion?
Well, the bigger analysis is complicated, because the stress
test also has other features. Another feature of the stress test
is that if a bank happens to be vulnerable to these types of
shocks, then it mandates that it has to raise capital. That


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

means it’s hard to know whether it was the fact that information was released or it was also the fact that they were obliged
to raise capital.
On the other hand, the ECB conducted a stress test that
didn’t have the second element. It only has the informational
release. Where the Europeans focus on the information, they
have some other problems in their design.
It was thought by most participants that this was not a credible stress test. Nevertheless, even under these suspicions, people found calming effects from the stress test in Europe. So I
will say that it’s hard to know. These are complicated. But my
reading of the evidence is very supportive of Bernanke’s view.

The paper’s main takeaways, according
to Alvarez:
• In moments of financial crisis, intervention that
otherwise would not be a wise policy may be
• This is not particularly bothersome. It’s mostly
about a release of information.
• It’s a public policy that is reasonable from the
perspective of analyzing social cost and benefit.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Hazel Fyfe Professor in Economics, University of Rochester
Paper: “Resurrecting the Role of the Product Market Wedge
in Recessions”
(with Peter Klenow and Benjamin Malin)

I was wondering if you could tell us a little bit about what
your paper is about and what the question is.
The paper is with Pete Klenow and Ben Malin, and anything
I say shouldn’t be attributed or held against them.
The starting point is well-known, that we don’t really understand what happens in recessions. In recessions, there’s a big
drop in employment and hours. At the same time, consumption drops a lot. So, given the drop in consumption and
that hours and employment are low, we would expect, and I
think it’s reasonable to expect, that people would be willing
to work at a lower rate of pay. So the reservation wage for
workers, what they’d require to work, should be low.
At the same time, for most recessions, productivity doesn’t
fall that much. For the last three recessions, which is the
period we look at, the last 25 years, on average, labor productivity doesn’t really drop. So then you have this puzzle.
Why is it that people are getting laid off or that firms aren’t
creating jobs or the work weeks are cut, even though it looks
like the return on labor doesn’t look bad? The productivity
looks pretty good, given what people would want to work at.
That’s referred to as the labor wedge. It shows up in other
places in the literature. The whole unemployment puzzle,
sometimes called the Shimer puzzle, is very closely related.
So that’s our starting point. And then in the literature, a lot
of that has been stressed as a problem from the labor market.
It’s natural, because you’re trying to understand why labor
drops so much in recessions. So it’s viewed as, “What’s the
problem with the labor market?”
And so people have looked at average hourly earnings in the
data and say, “Well, average hourly earnings also don’t fall that
much during recessions, maybe a little bit compared to productivity, but not so much.” So maybe the problem is in the
labor market. What’s keeping the wages sticky or not falling?
We make a couple of points. One is we don’t really know
how to measure what the price of labor does in recessions,

because we know that firms smooth people’s wages. New
hires’ wages drop a lot more.
You mean the price of labor to the firm may not be fully
reflected in the, say, the wage that they’re earning at
that point?
Right. Suppose I don’t cut all the wages for my long-term
employees, for convenience or to try to provide some insurance for them. That doesn’t mean that I can’t go out and find
somebody new who would be cheaper, for instance.
We show that, for various different ways of measuring the
price of labor, there is quite a drop in the price of labor
compared to the productivity. It looks like the problem is
not wage stickiness, but just that the demand for labor really
is dropping a lot in recessions, just not in a way that we can
link to productivity.
What we show then is, in a few different ways, that if we
look at lots of inputs that don’t get purchased through the
labor market, we see very much the same phenomena. I’ll
just mention a couple. We look at self-employed workers,
and we see very much a similar phenomenon, even though
of course they don’t have any bargaining problems with their
employers. They’re self-employed. They work for themselves.
And we look at intermediates. Intermediate purchases are
huge in most industries. It’s like half of the value of their
output. We see that the price of the intermediates drops a
lot, yet the inputs drop a lot, and we see the same puzzle:
that the firms seem to be pulling back a lot on intermediates,
even though the productivity looks quite good.
We’re basically arguing it’s not a problem in terms of wage
setting in the labor market. It’s a more general problem of
firms drawing back and being more reticent to put output
out on the market in recessions, and it’s just causing all
factor demands to drop.


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

There are some people who have claimed that there’s some
sort of composition bias. The workers you see laid off in
a recession are the less skilled, lower productive workers.
And as these workers are laid off, this raises the average
labor productivity of the people who keep the jobs. Do
you have any view on that?
You can calculate how big that is. And that helps to explain
a little bit. You can just do sort of a back-of-the-envelope
calculation. In a recession, for every percent fall in hours,
maybe three-quarters of that is employment. The guys who
are getting laid off are maybe 20 percent less productive.
And then you can calculate that it makes a little bit of difference in measuring productivity.
I can do other calculations, though, that would suggest
that productivity actually drops even less in recessions. If I
have any overhead labor, any overhead factors, the fact that
I have to keep them on in the recession would tend to cause
productivity to drop even more. So these things tend to, I
think, kind of offset.
Also, that compositional bias shouldn’t show up for the
factors we’re looking at, like intermediates.
So your findings then would call into question these
approaches to try and understand recessions that focus
on problems in the labor market, labor market frictions,
things like this, and move the focus someplace else. Like
what, where?
Well, I would say it a little differently. We would like to say
that the focus shouldn’t be only on that. I wouldn’t argue that
there aren’t some distortions coming from the labor market
as well as the goods market. It’s just that I think the literature
has moved to say it’s almost all in the labor market, and it’s
largely based on looking at, like, average hourly earnings.
In fact, we say this literally: We think both what’s happening
to other inputs and in the goods market deserves attention in
the same way that the labor market does.
Do you have any, like, pet hypotheses here? What’s going
on in the product market?
Let me just say again what we see and some possible explanations. We see that productivity does not drop so sharply in
recessions, but the cost of a lot of inputs seems to be falling.
So what could that be?


Well, one natural story would be that the firms are raising
their markups during a recession, so they’re pulling back
and they’re pricing higher. That shows up in Keynesian
sticky price models just because the prices are slow to
respond. I think these effects are bigger and longer than
what one would get out of that story, in particular for the
Great Recession. We see this for all three recessions, but this
markup, this product market wedge, is particularly striking
for the Great Recession.
So it could be price stickiness. It could be that firms feel like
it’s a time where, if you try to keep producing at the same
way you were, you’d have to slash prices so much that it
doesn’t make sense.
A paper by Simon Gilchrist, Raphael Schoenle, Jae Sim and
Egon Zakrajsek shows that, after Lehman Brothers, firms
that had cash flow problems raised their price relative to the
other guys. Their explanation was that these firms couldn’t
afford to invest in their stock of customers. They had to get
money now, so they had to charge a higher price, even if it
cost them some of their customer base. They didn’t want to
do it, but it’s just a form of cutting investment.
And I would say more generally, any decision at the margin
to produce more is partly an investment. So when a firm
hires a worker, it’s always partly an investment. You don’t
know whether they’re going to be good or bad. If you really
were just hiring based on that day, would you ever hire these
guys? They might come in and screw things up for the day.
There’s always an investment component to producing more.
Because there’s less investment, firms will act like, “Well, I’m
going to be more reticent to produce in the recession.” And
that will show up as moving up a demand curve to a higher
price, causing an increase in price markup.
I would also mention a paper by Cristina Arellano, Yan Bai
and Patrick Kehoe. They show that, if uncertainty goes up
in a recession and firms don’t want to overextend because
they might go under and lose the whole firm, that causes
firms to be more reticent and pull back more on producing
in a recession.
All these forces lead to less dynamic, less competitive markets in a recession. I think it could cause markups to go up.
That’s what we’re arguing: People should be focused on these
other forces as well as, say, wage setting.
In any case, it does seem to rule out some forces, like
productivity shocks or stuff like this.
The acyclical data on productivity speak pretty well to that.
It doesn’t mean there’s no role for them. But there has to be,
I think, other shocks that are more important.

In recessions, firms don’t want to hire. I can’t rationalize that
with a productivity shock, because productivity just doesn’t
fall enough.

Productivity and Hours


Again, I’m not speaking for Pete or Ben, of course. I don’t
think in terms of policy, but I would say the following: We
don’t know what’s causing labor to fall in recessions. We
don’t think it’s primarily wage stickiness. It’s likely factors we
don’t understand well. If we recognize that we don’t understand recessions, that has important policy implications. You
should tread lightly. That would be a lesson I would take. I
wouldn’t take a view based on recessions that the labor market just doesn’t work well. That opens the door to all sorts of
escapades in policy.
Our work reinforces that there are costs to recessions from
inefficient drops in employment. But then what’s the right
policy response? I could say, “Well, we should do things
therefore to subsidize activity more in recessions.” But
sometimes that’s counterproductive. If I look at policies that
get made not according to rules, but ex-post, sometimes
they make things worse. They create a situation where you
don’t know what to do as an employer or firm because, even
though you’re not necessarily in the rent-seeking business, in
those times it pays to be.
I can give two examples. Assume we’re in a recession and you
think maybe we’ll get a big investment tax credit. Maybe
we won’t. Maybe it’ll come next year. So what should I do? I
should invest less so that I would delay my investment until
the tax credit kicks in.


(Index 2009=100)

You don’t make any explicit policy recommendations
on your findings, but do you see how your line of work,
your line of inquiry, might one day inform policymakers
in a particular manner? Or is it too removed from that
right now?











Business Sector: Real Output Per Hour of All Persons
Business Sector: Hours of All Persons
NOTE: Shaded areas indicate US recessions.

The lesson I would take is: Do nothing, or use a rule. If
policymakers could credibly have a rule that, when employment falls a lot, we’re going to have an investment tax credit
or we’re going to have some payroll tax cut, I think our
results could help rationalize that. But if a policymaker can’t
explain and commit to what they will do under some future
scenario, then I don’t think we should trust their choices
after the fact on these policies. That’s my view, but, again,
not necessarily Pete’s and Ben’s.

The paper’s main takeaways, according
to Bils:
• Recessions look quite costly. Not just labor, but
all down inputs drop sharply in recessions despite
little fall in productivity.
• We see this as a product market distortion that
cuts demands for all inputs in recessions.

Around 2009, there was a lot of discussion of creating a
subsidy to hiring, so that if firms did net hiring, you would
get a payment from the government. This is a terrible idea.
Firms have to sit around and make calculations like, “I don’t
want to hire now, because if I do, then I lose out on the
subsidy. Better to let workers go, making room to hire when
the subsidy kicks in.”

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

Paul W. Frenzel Land Grant Professor of Liberal Arts and Professor
of Economics, University of Minnesota; Founding Director, HellerHurwicz Economics Institute
Paper: “On the Optimality of Financial Repression”
(with Alessandro Dovis and Patrick Kehoe)

This is a very provocative kind of title, “On the
Optimality of Financial Repression.” What do you
mean by repression?
Financial repression is a term that’s often used to describe
policy measures by governments which require, in particular
banks, but more generally, other intermediaries—like savings and loans, insurance companies, pension funds and the
like—to hold a lot of government debt in their portfolios.
That is, that besides private assets that they might hold—like
loans to households, mortgages and so on—they’re often
required to hold a lot of government debt.
Would required reserves on the part of banks, for
example, constitute a form of financial repression, kind of
a legislated amount of a certain type of government debt?
Right. Typically, these are requirements that are justified
in terms of safety and soundness. It says that, in order for a
bank to meet its regulatory standards, it must hold a sufficient
amount of so-called safe assets. These safe assets typically refer
to the debt of the government where this entity is located.
So the repression refers to the fact that these entities are
required, kind of against their will, to hold these types
of assets, I presume. So what is the question that you’re
interested then in addressing in this paper?
Historically, this issue has largely been studied within the
context of ensuring that banks particularly continue to be
safe. But we take a somewhat different perspective on this.
We look at the broad sweep of historical experience. Oddly
enough, it turns out that whenever governments need to
issue a lot of debt—the United States during the Civil War
is one example of this; more recently, we’ve seen this need in
Europe—that’s when implicit or explicit regulations requiring financial intermediaries to hold debt seem to go up.
These banks and similar institutions end up holding a large
fraction of their portfolio in the form of government debt.

We thought that was a striking and interesting observation, and so we were led to ask why. What we argue in our
paper is that this phenomenon is very hard to understand if
governments can in technical terms commit to their future
policies. So what that means is that, if a government can
choose what policies it’s going to follow for a long period
of time and stick to those policies, then requiring banks
to hold this kind of debt is a very inefficient way of raising
revenue. There are much more efficient ways of raising the
revenue needed to finance a war or of issuing government
debt during a recession, precisely because forcing banks to
do this implies that banks will be able to finance less private
investment, and so therefore the economy will be worse off
as a consequence of these policies.
However, what we argue is that, in a world where people
are concerned about the possibility that governments might
default on their debts, either explicitly or implicitly through
inflation, then these policies remarkably start to make sense.
They make sense because if banks and other intermediaries
are holding a lot of public debt, then a default endangers the
financial system and therefore tends to make the situation
a lot worse. And because the situation is going to be a lot
worse, governments are dissuaded from defaulting.
Therefore, from the perspective of governments looking
ahead, this mechanism turns out to be a useful device to
commit yourself to not default in a world where it’s difficult
to convince investors that you will not default on that debt.
So, paradoxically, something that is very bad, if governments
can pick policies and stick to them, turns out in fact to be
a necessary and a desirable instrument in a world without
So what you’re saying is basically that, in a world
where the government cannot commit to its promises,
say, to repay debt, that if it forces the domestic banks
to overload on the domestic sovereign debt, that this
would increase the costs—the economic and presumably
political costs—of the government from defaulting.
And the threat of that is what enhances the ability of the
government to refinance?

That’s exactly right. And so these forces are likely to be
particularly strong when the government needs to issue a lot
of debt, because when they issue debt, investors will buy the
debt only if they think that the government is unlikely to
default. But if you’ve got a situation in which you’ve already
fought a war—think World War II or something like that—
and you’ve issued a lot of debt during the war, come peacetime, you have a strong incentive to say, “Well, let’s default
in part on that debt through inflation or through explicit
kinds of means.”
How does that help you? That means that valuable resources
which would have been used to finance other kinds of
expenditures no longer have to be used to pay interest on
government debt, and so therefore the distortions that occur
because you’ve got this big overhang of government debt are
much smaller.
Presumably, this is not the only way government could
build commitment or enhance its commitment to repay.
There are also political costs to, say, consumers and
households who would be loaded up on this domestic
debt. In your paper, you don’t actually focus on that.
You’re focusing on the potential costs through the
banking sector, not the political costs?

Banks Holdings of Gov. Debt / Banks Assets

Like any good paper, we hope, we wanted to focus on one
issue rather than take on a whole gamut of issues. And so we
chose to focus our attention on this particular issue, rather
than discuss the broader ramifications. I have a bunch of
papers which address those broader ramifications as well.

You mention, and I think it’s pretty well-known, that it
seems unusual that, say, Italian banks seem to be loading
up disproportionately on Italian sovereign debt. But we
don’t necessarily see any explicit government regulations
requiring these banks to behave in this manner. Could it
be that there are natural market forces that would lead,
say, Italian banks to load up on Italian debt?
Yes, there are some market forces. The nature of regulation
is a little complicated and a little subtle, because, especially
as far as the banking system is concerned, private banks
are in fairly close touch with their regulators. And their
regulators evaluate the safety of these banks through a
variety of different kinds of metrics. It’s not just specific,
written-down formulas.
We think of a lot of this kind of regulation as being implicit,
not quite out in the forefront, not specifically in any written
rule or regulation. But, yes, there are perhaps other forces
that would lead Italian banks to load up on Italian government debt. Those forces tend to be weak because banks do
have—in a reasonably competitive market system—strong
incentives to diversify their portfolios.
And so, therefore, holding Italian government debt is a particularly undiversified form of risk if you’re holding a lot of
Italian mortgages or loans to Italian firms, because that debt
is going to become relatively less valuable exactly when the
rest of the Italian economy tanks. So normal market forces,
you’d think, would give Italian banks a strong incentive to
hold German debt and German banks to hold a lot of Italian
debt. Instead, we tend to see in practice the exact opposite.
Suppose, for whatever reason, the Italian banks feel
that the Italian government is less likely to default
on their sovereign debt that’s held domestically. And
suppose that this is true throughout Europe. You’d like
it to be diversified, but if what I just said was true, this
sovereign debt would be relocated to its domestic sources.
That maybe reinforces your paper. This is not through
explicit government regulation, but they know that the
government is less likely to default if it’s held domestically.






Total Gov. Debt / GDP











I think that is very complementary. One can certainly imagine those kinds of forces inducing banks to understand that
it’s in everybody’s cooperative and best interest to hold a lot
of Italian debt. So I agree. I think the kind of story you are
telling complements the story we’re telling fairly well.


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

In terms of policy implications, what do you feel are the
main lessons that policymakers might draw from the
findings of your research?
A very pressing and central topic in Europe, for example,
right now is that the plan is that the European Union will
have a central regulatory and supervisory authority, which
will be run perhaps out of the European Central Bank in
Frankfurt and in Brussels. And that authority will have the
primary responsibility for supervising all the banks from
Portugal to Ireland to Germany and Austria, as opposed to
the current practice, which is that the national regulatory
authorities regulate their own domestic banks.
And an important issue that’s being discussed as we speak is:
How should these regulations be set up? And there are lots
of forces in Europe arguing on very sensible grounds that
national banks—banks in Portugal for example—should
not hold an excessive amount of Portuguese debt. That
makes them vulnerable to the possibility that Portugal might
default on its debt. And so, therefore, they should be induced
or required to hold German debt, for example. And there are
good reasons why you might think that that proposal is a
good idea.

What our research suggests is, maybe not so fast. Maybe
there are good reasons why Portugal or Greece or Italy or
Spain might require their own banks to hold their own
national debt. We should take those considerations into
account in designing policy. Far be it from me to suggest
that the considerations we’re pointing out are the only ones
that should guide regulation, but we think it is an important, perhaps very important, consideration that they should
keep in mind. So maybe the European supervisory authorities should think twice before it harmonizes regulations
across Europe.

The paper’s main takeaways, according
to Chari:
• Good economics always has the property that
things that seem like a puzzle on the surface,
through deeper analysis, turn out to be less of
a puzzle.
• Good applied economics has useful and interesting policy recommendations, and I hope our
paper has that as well.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Richard Meese Professor of Economics, University of
Wisconsin, Madison
Paper: “Spatial Variation in Higher Education Financing and the
Supply of College Graduates”

There’s a lot of money spent on financing higher education,
mainly by the states in the U.S., and the amount of money
spent is quite variable from one state to another, even for states
that are quite close by, for example, North and South Dakota.
The question that I’m interested in is what the states are
getting for the money, that is, what the effects are of the
differences in spending, and in particular whether a state that
allocates a lot more money—by way of spending on the colleges in the state or subsidizing the tuition payments for the
students—sees a change in the composition of the labor force
in the sense that the state has more college graduates sometime later than they would have had if they hadn’t introduced
these subsidies.
The issue, to a large extent, is whether the intervention that
affects college enrollment decisions actually sticks in the
place where it’s applied. There is an incentive for people to
move toward labor markets where they can, obviously, get the
highest return for their education. So if a state subsidizes its
students to acquire college degrees, the students might wander off and go use that human capital in some other place.
It would seem odd that a state would subsidize its education for students within the state only to see them leave.
What do you find? What do you discover? What is the
answer to the question of why this heterogeneity exists?
The effects are quite substantial in terms of the choices that
students are making on enrollment, not just in terms of
completing college degrees, but enrolling in two-year colleges
or community colleges and emerging with at least a partial
university education. So on that margin, these policies, both
changes in expenditures and also changes in tuition levels,
have substantial effects. But there’s not much indication that
the effects are dissipated through migration. These are people,
particularly the college graduates, who migrate a fair bit.

Higher Education Expenditures and
Human Capital Distribution
Percentage of graduates, among those born in each state

Can you tell us a little bit about the questions that you are
pursuing in this investigation here?













1991 Higher Education Expenditure per potential student
(thousands of 2009 dollars)

The exercise I do in the paper is to look at the distribution of
people at age 36, starting at 19, making enrollment decisions
along the way and then making migration decisions, and just
count the number of college graduates at age 36, the number
of people with some college and the number who are just
high school graduates.
And the effects seem to stay where they’re applied. Something
on the order of a 20 percent change in tuition or subsidies
gives rise to something like an 8 percent increase in the number of college graduates in the state sometime later, like 15,
17 years later. So the migration activity is pretty active, but it
doesn’t undo the effects of these subsidies.
I should say these are preliminary estimates built on a model
that uses individual survey data from the Labor Department.
And the estimates so far have been done just for a single state.
But that’s the finding.
You mention in the introduction of your paper that this is
not the first paper to investigate these types of questions.
But what’s distinctive in your paper is that the migration
is explicitly modeled. What do you mean by that? How
do you distinguish what you’ve done here vis-à-vis what’s
been done elsewhere earlier in the literature?

Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

What was measured was the effect of that kind of a subsidy on the decisions that these students would have made
regarding going to college or not. The effects that were found
were quite substantial, but that doesn’t answer the question
of where these people will end up. And it doesn’t answer the
question of what happens when you do that kind of subsidy
for everyone in the state, not just for a select few.
The other kind of work that’s been done is to consider looking at just a count of the number of new college graduates or
the number of new M.D. degrees produced within a state,
and then when there is a surge in the flow of new graduates,
come back maybe 10 years later—this is a paper by John
Bound and co-authors at the University of Michigan—and
ask, “Does that surge in the flow of new graduates correspond
to a substantial increase in the stock of college graduates 10
years later in the state?” And the finding there was that it
really doesn’t tend to stick if you measure it that way.
What’s distinctive here is not just to take the flow as something that’s given for some extraneous reason, but to try and
think about what would happen if you deliberately change
the flow of new college graduates by means of a specific
policy intervention, and then, rather than just doing a count
of what the numbers are now and 10 years later, keep track
of how individuals make these choices, both choices about
whether they go to school and choices about where they want
to live and work.
So your model helps identify the reasons?
It certainly keeps track of the reasons that people are making
the choices, and it allows you to think about the choices that
they would make under alternative arrangements and alternative policies that they might face.


Percentage of native graduates who stay

There are two kinds of things that have been done. One is
to look at the effects of specific tuition subsidy programs,
where there are, for example, merit scholarships given out
to selected individuals. I think Georgia was the first state to
do this, and a number of other states have introduced it, the
HOPE Scholarship.

23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41
Percentage of graduates, among those born in each state

as college graduates are in some sense paying for themselves,
but the people who end up not going to college are also paying for the college graduates.

These kind of policies involve an implicit transfer from people
who don’t have so much money to begin with and giving the
money to people who already have quite a bit, so a transfer
from someone who is a high school graduate to someone
who is a college graduate. That’s a little surprising to see. To
see that these decisions are made very differently across the
U.S., that’s not something that the paper really addresses.
Indeed, it treats those variations as the outcome of some,
perhaps political, process where it’s largely accidental how the
numbers turn out. But that’s a very interesting question in its
own right.
Perhaps not this paper, but this line of inquiry you’re
pursuing, how might it feed into the policy debate?
How might it inform policymakers? Do you see any role
for your findings in how educational policies might be
designed going down the road?

Does your paper speak at all to the reasons for the
variation that we do see in subsidies?

I think it brings up the question of whether it’s beneficial for
the residents in the state as a whole to augment the level of
education in the state labor force. You will see the argument
made that, by having a more educated workforce, everybody
benefits, not just the people who have the extra education,
but that it spills over to the others in the state as well. It creates jobs. It enhances the labor market in some way.

Not really, and that’s somewhat mysterious. The subsidies,
the amount of money that’s allocated for higher education is
very substantial. And, of course, that has to be financed by
taxes on the residents of the state. So the people who end up

I don’t really get into that in this paper, but, certainly, you
want to know—if that’s your view of how the labor market
works—whether these large expenditures are actually going
to pay for themselves in the long run through some mechanism like that.

There are many ways to attract human capital to a
locality, such as offering an environment that’s conducive
to entrepreneurs or startups, that would be independent
of where they were educated. But I think what you’re
getting at here is the suggestion that the homegrown
talent is eventually going to come back, that the locals
who are financing this endeavor can rest assured that
your findings suggest that they will be coming back and
One thing that’s really important in looking at migration
data is that there is a very strong tendency for people to want
to live where they grew up. They will leave in many cases,
but they’ll often come back. So if you’re trying to change the
composition of the workforce in the state, you might try to
do it by attracting college graduates from other places, but
it’s likely to be much more effective to produce more college
graduates from your home population, because those are the
people who are most inclined to be in this location in the
long run.

The paper’s main takeaways, according
to Kennan:
• The decisions that people are making seem
quite purposeful.
• If you think about the reasons that lie behind the
choices that people make about going to college or
not, going to college for a year or two and whether
to continue, or going to a community college and
finishing in a four-year college, there seems to be
some evidence that these choices are quite systematic and that the subsequent migration choices are
similarly quite systematic.
• You can actually predict what the consequences
of changes in different policy variables will be,
and I think that’s encouraging.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

Willis H. Booth Chair in Banking and Finance, Haas School of Business,
University of California, Berkeley
Paper: “Competition and Bank Opacity”
(with Liangliang Jiang and Chen Lin)

Would you mind telling us about your paper?
I want to investigate what happens to the quality of information that banks disclose to the public and to regulators after
regulators reduce impediments to competition among banks.
So the general issue is: If there’s a regulatory change that
allows banks to compete with each other, so one bank can
enter another bank’s market, does that have an effect on the
quality of information that they disclose?
Quality in the sense of the quality of their balance
sheet, the information contained in the regular
statements required?
All firms, all corporations, including banks, have income
statements and balance statements where they describe how
much profit they’re making and what their assets are. And
they can do things with their accounts to make themselves
look a little bit better or look a little bit worse.
When we talk about information disclosure, it’s the degree
to which they are manipulating that information in order to
perhaps pass muster with the regulators on capital requirements or in order to look a little bit better in terms of profits.
Or they could even make themselves look a little bit worse if
they want to discourage new entrants as a way to signal that
the market’s not very profitable.
What particular regulations do you have in mind here, or
We look over a particular period in the U.S., starting in the
mid-1970s and going through to about 2000, when there
was a series of regulatory reforms that reduced impediments.
For example, one type of reform eliminated restrictions on
banks being able to set up branches within their own state.


For a long time in the U.S. and in many states, there were
restrictions on how many banks, how many subsidiaries,
how many branches a bank could actually have. Those were
removed, and that meant if I was in one part of the state
and you were in another part of the state, I could set up a
branch and compete with you. And that was disallowed
before by regulation.
Then there were other regulatory changes. For example, if
I’m in California, you’re in Missouri, and you want to open
up a bank in California, for a long time in the U.S. for most
of the 20th century, you couldn’t do that. And these restrictions were removed.
There were a variety of other restrictions that slowly allowed
banks to be able to compete with each other more vigorously.
Regulations come. They wax, and they wane. Is there a
presumption of what additional competition or the lack
thereof has in terms of bank opacity?
What’s nice from a research perspective, and I think also
from a policy perspective, is that it could go either way.
For example, many people argue that competition improves
efficiency. If this bank is going to be under threat, then its
investors—potentially both bondholders and stockholders—
are going to monitor that institution much more carefully
and perhaps induce it to provide much more accurate information and not play around with the numbers.
At the same time, if a bank or another firm is under a threat,
insiders may see that their horizons are short, and they may
want to manipulate the information more intensively in
order to get bonuses because the firm’s long-term prognosis
is not so great.
From a theoretical perspective, it could go either way. This
has implications for us today because it’s about what types
of policies are going to make it easier for the private sector to
assess what’s going on at a bank, and also for regulators.

“We get measures of how much of this
type of restatement is taking place before
a big change, how much is taking place
after or in the earlier measure where we
have a statistical model, and we assess
how much of this manipula­tion seems to
be taking place and whether it changes.
What we find is that it’s a very big change.
It goes down by about 40 percent.”

Yours is largely an empirical investigation. There’s a broad
class of theories that can go one way or the other. And now
you’re taking a look at some evidence. What evidence in
particular are you looking at?
What we do is we look at these regulatory changes that take
place in different states over different times, and we have
measures of the degree to which the bank is manipulating its
information before there was a regulatory change, and then
we see what happens afterwards.
Give an example of evidence that you have of
manipulation, how you can identify that in your data.
The accounting profession has many models of trying to
predict or explain loan loss provisions. Loan loss provision
is when a bank takes aside some money and puts it into an
account and says, “We’re worried that some of our loans may
not pay off, and we want to have this money there just in
case there’s a problem.”
When the bank does that, it lowers its income in that period,
and it increases measures of capital. The bank can use that
type of discretionary loan loss provisions. Maybe they don’t
really need to have loan loss provisions, but they do it anyway. Or maybe they want to boost their profits and look better to potential buyers, and then that way they’ll take money
out of loan loss provisions, and that comes in through the
income statement and looks like a profit.

But how can you tell whether this loan loss provisioning is
well-intentioned, or just for window-dressing purposes?
There are two ways we do this. One way to do this is
through a statistical model, and this again comes from the
accounting profession. We predict—using all the information we can—what we expect loan loss provisions to be,
how much we think banks are going to put aside. Then, we
look at the difference between our prediction from a model
and whatever’s left over. We can see whether that amount of
ignorance, that measure, changes systematically before and
after a bank faces competition.
The other way we do it is that banks also will restate their
earnings. What that means is they put together their loan
loss provisions. They release this information to the public—
income statements and balance sheets. Then sometimes a few
quarters later, they’ll go back and they’ll say, “Oops, we’re
going to restate it.” So we also look at that, because that’s a
very direct measure of whether the bank had to change its
accounts ex-post.
Restating financial reports is very common, but you’re
trying to discover whether this occurs more systematically
under one regulatory regime vis-à-vis another, I guess.
Exactly. We get measures of how much of this type of
restatement is taking place before a big change, how much is
taking place after or in the earlier measure where we have a
statistical model, and we assess how much of this manipulation seems to be taking place and whether it changes. What
we find is that it’s a very big change. It goes down by about
40 percent.
It goes down because of the regulations that permitted
more competition in the United States? These measures
go down?
Exactly. What happens is the measures of competition go up.
So as regulators remove barriers to competition, I can come
over to your neighborhood. You can come to California.
What we see after that is, both you and I, because we’re subject to greater competition, we manipulate our earnings less.
We restate our financial accounts less frequently.
According to your estimated model of loan loss
provisioning, you estimate that this kind of windowdressing tool is used less frequently in a more competitive


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

regime? So your empirics lend support to one side of the
theoretical debate and argue that increased competition
promotes transparency?
Do you have a view as to whether this is a good thing?
There are cases that could be made that some degree of
opacity is kind of desirable—like the Fed, for example,
does not disclose the identity of, say, the agents who make
use of the emergency lending facility, or at least delays
the disclosure. Do you have a view, or does your analysis
suggest anything, about the desirability of these types of
increased competition leading to greater transparency?
There’s a long series of papers that examine the relationship between bank opacity—or the degree to which banks
manipulate their accounts, the degree to which there are
restatements of their earnings—and bank performance.
What I mean by bank performance is you’ll see that banks
tend to be less stable, more fragile, when they manipulate
their earnings more. And this exists in other firms as well.
You also tend to see that lending becomes less efficient and
much more subject to the vagaries of the business cycle when
banks are more prone to manipulate their earnings or restate
their financial accounts.
Regulators also have a harder time following the banks when
their financial accounts are not as accurate as they could be.
So there seem to be these implications for bank behavior of
the degree to which banks manipulate their earnings. Our
contribution is to assess this question: Well, this one type
of policy change—whether increased or decreased competition—what was its impact on the bank? And it’s the degree
to which it manipulates earnings.

Let’s take a look at the Canadian banking system in
particular, which most people would characterize as less
competitive than the United States. And yet it’s widely
known that it displayed much more resilience during the
recent crisis in particular. Do you have any views on that?
Have you looked at other countries?
In this particular study, I haven’t looked at other countries.
One of the nice things about looking at U.S. states is that we
can hold lots of other things constant. Obviously, if you look
at Canada and you look at the United States, the differences
are going to be much more substantial. And it’s hard to
isolate the effect of one thing, like competition.
So competition is good for transparency, and transparency
largely provides a more resilient, more accountable
banking sector.
Yes, and I think it’s relevant for today, because especially
after the crisis, we have greater consolidation, perhaps a
feeling of “too big to fail” on the part of investors and banks.
This might be interpreted as an increased regime in which
there’s less competition.
What this paper talks about is not just the history from the
’70s and the ’80s, but it also speaks to what’s going on now
in terms of regulatory policies that might infringe on competition and the contestability of markets.

The paper’s main takeaways, according
to Levine:
• Competition tends to reduce lots of inefficiencies
in banks.
• We should be worried about policies and developments that are going to reduce competition
among banks.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Associate Professor of Economics, University of Pennsylvania
Paper: “Demand Stimulus and Inflation: Empirical Evidence”
(with Marcus Hagedorn and Jessie Handbury)

You’re looking at some empirical evidence behind the
relationship between demand stimulus and inflation.
Can you tell us a little bit about the exact question
you’re addressing?
If you don’t mind, I’ll start a little bit further back, which
might be helpful.
If you look at what happened in the U.S. economy in 2014
until now, what surprised a lot of people was an unexpectedly strong recovery of labor markets. Unemployment
declined substantially and employment increased substantially, so there is a roughly proportional flow of people
from unemployment into employment. Vacancies are at an
all-time high.
What caused this unexpectedly strong recovery? One
thing that comes to mind is that, in January 2014, massive
extensions of unemployment benefits, which started during
the Great Recession, came to an end. And it could be that
somehow that expiration of unemployment benefits caused
the recovery in the labor market.
So how would the story work? It’s very simple. When you
provide benefits to people, people tend to demand higher
wages in equilibrium, so wages go up. If productivity of
workers stays the same, but firms have to pay higher wages to
those workers, they have to hire fewer workers because profits decline and job creation goes down. That’s not to say that
people are lazy. It’s not to say that people don’t want to work.
Everybody wants to work. It’s just in equilibrium firms know
that after they hire workers they will have to pay higher
wages relative to workers’ productivity, and that causes a
decline in job creation, an increase in unemployment and a
decline in employment.
This was the theory assessed in the paper that I wrote a
year ago with Marcus Hagedorn, Kurt Mitman and Fatih
Karahan where we very carefully measured the effects of
unemployment benefit extensions and found very sizable
negative effects on employment. Unemployment benefit
extensions also increase unemployment and cause a decline
in job vacancies.

Negative in those measures, but the insurance aspects
could have had positive effects?
Exactly. One of the aspects in which our research was criticized was as follows. The argument was made by the Council
of Economic Advisers and by the Congressional Budget
Office that, “Look, unemployment benefit extensions is one
of the best stimulative policies out there. It provides money
to people, who would spend that money, will stimulate
aggregate demand, will stimulate the economy and could
have substantial positive effects on the economy.”
And so the real motivation for this paper is trying to evaluate, “Is it really happening? Is the effect of unemployment
benefit extensions on demand stimulus really as big as the
models that policymakers are using suggest it is?”
You’re asking if the demand stimulus effect of, say,
extending unemployment insurance benefits is as large as
these models suggest. But what does the evidence suggest,
first of all?
It’s very hard to measure the effect of stimulus and to know
directly whether stimulus has a big effect or a small effect.
Suppose there is a state that has a lot of unemployment. You
increase stimulus there, and you see that the economy recovers a little bit. It’s not clear if it recovers a little bit due to
stimulus and the stimulus effect is not too big, or maybe the
conditions in that state or that location were bad and maybe
even becoming worse. So it’s generally very difficult to tease
out how big this effect is.
And this is not what I’m doing in this paper. Instead, what
I really want to assess is the quality of the models that policymakers are actually using and that generate big effects of
stimulus. Are those models consistent with what we observe
in the data or not?
So the models that justify, in policymakers’ minds, the
positive effects of these types of stimulus programs, you’re

Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

interested in taking their models and interpreting the
evidence to see to what extent their models are consistent
with this idea that this type of stimulus in particular is
effective. Is this the idea?
That’s an excellent description of what we do.
Tell us exactly then: What do you do, and which model do
you have in mind of evaluating?
Let me explain how standard models work and how policymakers usually think about it. Their reasoning is usually
based on models in which prices are sticky. That is, there is
some friction that prevents firms from adjusting prices. Now,
suppose you provide money to people, and they spend this
money to buy stuff. This increases demand that firms face, so
firms, given that they cannot adjust prices, sell more.

That’s exactly where this paper comes in. We want to see
whether unemployment benefit extensions—so spending on
benefits—really changes inflation in the way that is consistent with these models and in the way that is consistent with
big, sizable stimulative effects of those policies.

What happens? People know that eventually firms will adjust
prices, so prices will go up. And now consider the case of
the zero lower bound on interest rates or the notion of the
liquidity trap, which a lot of people argued characterized the
economy in the last few years. Simply put, the idea is that
the nominal interest rate is fixed at some low level.

We identify counties in the United States which belong to
different states but border each other. Now, unemployment
benefit extensions are set at the state level. When economic
conditions trigger unemployment benefit extensions, they
are extended at the state level and apply to all counties
within the state. This is the key part: It’s not the economic
conditions of a particular county that determine unemployment benefits in the state. It’s the total effect of the economic
conditions in the state that determines the benefit policy that
applies to all counties. And then by looking at two counties
that border each other but belong to different states, we can
isolate the effects of spending on benefits by observing what
happens to prices and inflation. In those locations, we can
identify the effect of stimulus spending on inflation.

And so then if you expect prices to go up, it means that you
want to buy today. You don’t want to delay your purchases
into the future. In more formal economics terms, it means
that real interest rate has to decline today, and this induces
people to go out and buy stuff today. And this reinforces
the effect of the original stimulus. People go out, they spend
more, it amplifies the effect, and you can generate big stimulative effects from these policies.

So the idea is to consider two counties that border each
other that are in different states and consider one state
that, say, enacts an unemployment insurance extension
program. Then, you want to study the behavior of these
two counties that border each other to see if they react
differently. And suppose they react differently. What do
you discover then?

In the context of these models that you’re interested in
evaluating, when the nominal interest rate is at its lower
bound—which it is today—this type of stimulative
program means: You write checks for people. They’re
going to spend more. Firms are going to increase their
production, and people are going to foresee that prices are
going to rise in the future…

In the class of models that policymakers are using, there
is a particular mathematical relationship called the New
Keynesian Phillips curve. It has a very intuitive interpretation. It says that inflation today is proportional to how costly
it is for firms to produce the last unit of output they are
producing plus expected inflation tomorrow.

And they want to spend even more today.
So this induces them to spend now before the prices rise?
Exactly. And why it might not happen outside of the zero
lower bound is that it could be that monetary policies of
central banks can undo some of those effects otherwise.


So this type of stimulus program will generate an
inflation. That’s what the standard model predicts. How
do you evaluate this?

So inflation is a function of what firms believe to be the
costs of production, not only today but also…
Going forward, because remember prices are assumed to
be sticky. If prices are sticky, it means firms may not be
able to adjust prices for some time even if their costs of
production change.

“By looking at two counties that border
each other but belong to different states,
we can isolate the effects of spending
on benefits by observing what happens
to prices and inflation. In those locations,
we can identify the effect of stimulus
spending on inflation.”
So they have to make a forecast of how their costs are
going to evolve in the future. How does this relate into
extension of unemployment insurance program?
Extensions of unemployment insurance programs mean that
you provide a transfer. Recall it’s very important that these
extensions are financed at the federal level.
When the unemployment benefits go into a particular
county, it’s a pure transfer of resources into that county.
When the resources enter the county, you would expect
prices to go up, and you would expect marginal costs of the
firm to go up because now firms have to hire more workers,
they have to ramp up production and costs of doing so go up.
What you’re saying is that the unemployment insurance
benefits extension in the one county should stimulate
more inflation vis-à-vis the neighboring county that did
not. That’s the implication of the theory?
Yes, but with one caveat. It’s very important to measure
inflation in a way that is consistent with the model. It’s not
just pure inflation. It’s so-called quasi-differenced inflation.
It’s inflation today minus expected inflation tomorrow. It’s
this object that is related to the cost of producing for firms
in the model. By looking at the data through the lens of
the model, it’s this change in prices that informs us about
the changes in costs of firms and about the potential size of
stimulative effect.
What sort of data do you have that permits you to identify
this object?

We use Nielsen retail scanner data. It’s a dataset which has
approximately 40,000 retail stores, and we see the sales of all
the goods they sell at a weekly frequency, the volumes they
sell and the prices at which they sell each good.
When we look at those prices, they do not evolve in the way
that the standard model would predict. In particular, the
evolution of prices suggests—if you interpret that evolution of prices through the lens of the standard model with
sticky prices—that the costs that the firms are facing are not
affected by fiscal stimulus. This basically means that fiscal
stimulus or transfers of resources to a county do not drive up
the costs of the firms, they do not drive up expected inflation, and so they cannot have any stimulative effect.
It had no effect on inflation, but these unemployment
insurance checks, did they stimulate spending?
Without driving up marginal costs?
Again, it’s a little bit of a subtle question. They do not drive
marginal costs or costs to the firm only if you measure those
costs the way the models the policymakers are using tell you
those costs have to be measured.
You can measure it in a much simpler way. For example, you
can ask, “Do total sales of firms increase when consumers in
a county receive transfers?” And the answer is yes, so those
transfers do increase sales and consumer spending.
You can also just look at prices, without measuring them in a
way consistent with those models, that is, without taking the
difference between the prices and expected prices tomorrow.
If you just look at prices in this way, you see a fairly strong
response. Prices do go up in counties that receive transfers.
In this sense, there are stimulative effects of these policies. If
you try to interpret those effects through the lens of sticky
price models on which policymakers rely, you would say that
those effects are not there.
That’s a very subtle point you’re trying to make. What
you’re suggesting is that these types of programs may
be stimulative but not for the reasons that policymakers
typically think. Would that be fair?


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

That’s a fair interpretation. Essentially, if you really believe
in the class of models that policymakers are using, those
policies are not stimulative, or they’re stimulative but not for
the reasons underlying those models.
It’s natural to expect some stimulative effect even if you
take a pure, frictionless model with no frictions on prices,
for example. In those models, transferring resources to a
particular county would stimulate spending at least to some
extent, so you would expect some effect along the lines of
what we find. What you do not find is this big amplification
of the effect through the sticky prices mechanism underlying
policymakers’ thinking.
The policymakers that are relying on these types of
models to organize their thinking on other matters, they
may be flawed I suppose is what you’re saying. Are there
competing models that might do better? Do you talk at all
about them?
We do some. In particular, we look at one class of models
which also feature pricing frictions: the sticky information-type models. The idea there is that once in a while, let’s
say, the grocery store managers make a forecast of how they
expect the economy to evolve. They program their computers, they program a pricing plan, and so there are prices that
evolve over time according to those pre-specified plans. And
people infrequently update those plans in light of the new
information that they collect. It’s just too costly to do it very
often, so people only update those plans occasionally.
There’s a competing model that potentially does better.
There’s the conventional one that doesn’t do so well. What
sort of mistakes might policymakers make by relying on
this model vis-à-vis the one that you just described that
does a bit better? Would they imply different types of
approaches to stimulus?

How many data points do you have in your paper in
the dataset?
A lot. In the dataset on prices we have 76 billion observations. It’s a massive amount of data.

The paper’s main takeaways, according
to Manovskii:
• A lot of well-intentioned policies could have very
negative impacts which counter the original
design. For example, the policy of unemployment benefit extensions—either motivated by
its potential stimulative effects or by the desire
to help unemployed people—may actually hurt
unemployed people.
• This is not because the unemployed are somehow lazy. On the contrary, unemployed people
are desperate to work. However, unemployment
benefit extensions improve workers’ well-being
when they are out of work. This puts an upward
pressure on wages of those employed. Faced with
a fixed level of workers’ productivity but higher
wages due to the policy, firms are not creating
jobs because it becomes more difficult to cover
the costs of job creation. And those unemployed
simply do not get a chance of having a job. So
the well-intentioned policy which tries to help
unemployed people can actually hurt unemployed
people and hurt them substantially.
• We have to be really, really careful about thinking
and understanding the effects of these policies. In
particular, the models on which policymakers rely
and which imply large stimulative effects are not
consistent with the data.

The question is, “How big are the effects of stimulus?” The
sticky information model would predict much smaller effects
of stimulus than the original model, so the wisdom of stimulative policies could be called into question.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Professor of Economics, Yale University
Paper: “Did the Job Ladder Fail After the Great Recession?”
(with Fabien Postel-Vinay)

Describe for us what exactly a job ladder is and what it
means for it to fail.
I think everybody understands that there are high-paying
jobs and low-paying jobs, and, in life, people slowly climb
what we call a job ladder, meaning they slowly and by luck,
by and large, find these higher paying jobs and occasionally
fall off the ladder. They get fired, and this has long-lasting
consequences for their earnings for a long time.
What we do in this research project, with my co-author
Fabien Postel-Vinay from University College London, is
look at what this job ladder implies for business cycles, why
so many people lose jobs in recessions, why it takes so long
to regain employment out of recessions and why the job
recovery has been so slow. In past work, we actually looked at
many recessions and many business cycles in many countries.
In this work, we actually focus on the Great Recession, on
the last cyclical episode, and we do find something different.
Let me tell you a little story for basically what we distilled out
of the research project and why the Great Recession is different. When unemployment is high, it’s actually easy for firms
to hire. There are plenty of people knocking on the door. It’s
actually particularly easy for small firms, which are low-paying firms, to hire. They don’t lose workers to other firms,
there is no poaching, there are no quits, everybody is desperate for a job, and so small firms are relatively unconstrained.
When unemployment is low—as hopefully it will be in the
U.S. in a year or so, as it’s already falling—it gets much
harder for firms to hire. So large firms start poaching people
from small firms and the job ladder really picks up. This is
what we see in the data. Small firms, as a consequence, actually do relatively well relative to large firms in recessions and
early recoveries. So small firms actually are the engine of job
creation, as many people say, but only when unemployment
is high, which is probably when jobs are needed. And when
the economy tightens, large firms are actually leading the
charge, and that’s where wages really rise.
Now, the Great Recession has been different. Something
happened, something we don’t actually dig into, that made

small firms suffer more than in previous episodes. Overall,
they still did just as badly as large firms, but usually they do
better in recessions. This all sounds counterintuitive, because
most people have in mind that small firms are the ones who
suffer more in recessions. Their credit is tighter, but the data
speak quite strongly in favor of the pattern that I described.
In this particular recession, small firms did suffer. What
happened was that there was no room created at the bottom
of the job ladder because the small firms were suffering. They
were not hiring, large firms were not poaching, the job ladder stopped working, and so these jobs at the small firms—
which are the typical gate of entry for unemployed into
employment or re-entry for the unemployed into employment—didn’t open. These jobs at the bottom were not there.
Now, why is that? Why did this happen? We have different
conjectures about why these quits declined. People maybe
were scared about quitting their job and taking a gamble
without a job because unemployment was so bad. But that’s
essentially what happened.
Then we looked at a host of data to corroborate this story,
and we actually find that the movement of people up the
job ladder is probably the one indicator of the labor market
that has still not recovered. Unemployment has come down,
employment has gone up, hiring rates are healthy again, but
the job-to-job quit rate is still almost as low as it was five or
six years ago.
So it’s the large firms that are still not hiring and
that are stopping the job ladder from working?
They’re not poaching?
They are not poaching until recently, mostly because unemployment was still high, so it was relatively easy to hire. You
know, poaching is costly. You have to hire somebody out of
another firm. You have to pay them more. As long as there
are unemployed out there, firms tend not to do that and
essentially poaching increases both when there are lots of
people to be poached because they work at low-paying jobs
and when you run out of the unemployed.


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

The Great Recession was not just a scaled-up version of
what happens in previous recessions. Something different
happened. Could you reiterate what was different?
That’s exactly the point of the paper. What was different was
that small firms suffered more. They suffered more relative
to previous recessions and relative to large firms. So the
experience of small firms was unusually painful. Large firms
still did pretty badly, but usually they do worse. This time it
was really across the board.
I guess you speculate on why that may be, that small firms
may have been disproportionately hit this time relative to
history. Does it matter why, for the story you’re telling?
To some extent, it doesn’t. Our story is not about what caused
all this. It’s why employment is not recovering fast. So this
idea that there is a ceiling, there’s something keeping employment from climbing this ladder. Now, if we want to speak
about the causes, which I think is important, we know this
has been a financial-crisis-caused recession. There are plenty
of reasons why small firms have a harder time having access
to credit. And so this time, they may have been particularly
affected by the recession, more so than in previous ones.
What was not, I think, understood previously is that this
was set in motion, this chain of events where these allegedly
low-paying bad jobs disappeared. But these are actually
important jobs because they, again, allow the unemployed
to restart the process of regaining their earnings, and this
time it didn’t happen. We believe it’s no coincidence that
wages have not responded. So the one thing that’s still flat
is wages, and we have seen in previous recessions that wages
will recover when large firms will start poaching. Until that
happens, wages are going to just stay flat.
A lot of theories have this property that unemployment
will spike and then show a gradual decline just because
it’s very easy to destroy relationships and costly to build
them back up. This is a part of your story, but you get into
deeper details of exactly how this is working, I presume.
Does this imply anything specifically about the way
policymakers might want to design policies relative to
kind of a more naïve view of how this process is working?
I’m glad you asked, because we have some strong claims
about policy. Actually we think there are ramifications
for policy on two dimensions. First, there are well-known
policies that cater to small businesses. The Small Business


“We actually find that the movement of
people up the job ladder is probably the
one indicator of the labor market that has
still not recovered. Unemployment has
come down, employment has gone up,
hiring rates are healthy again, but the jobto-job quit rate is still almost as low as it
was five or six years ago.”

Administration is one example. They provide loan guarantees
and subsidized loans to small firms.
Now, we think we should also consider the hiring constraints the small firms face, and that those actually tighten
in expansions, in booms, not in recessions. This idea that
small firms need help in recessions because they can’t have
access to credit is only part of the story. Facing this hiring
constraint actually seems to be, on average, stronger and
more important. They have a hard time hiring and a much
harder time retaining talent in expansions. So in a broad
sense we may want to rethink some policies that are designed
in terms of firm size.
Now, more specifically, and that’s another policy implication, like I said, we think that wage growth is intimately
related to this pattern of growth of large and small firms.
Large firms pay much more, and a lot of wage growth that
people experience comes through changing jobs and being
hired by better firms.
We actually have a conjecture that the monetary authority
should stop looking only at unemployment as an indicator of
slack for wage growth and should actually start considering
and looking carefully at the job-to-job quit rate, because the
two are not perfectly related. There are situations like the
current one in which unemployment is reasonably low by
now, but this quit rate, this job ladder is not working yet. In
these cases, we should not expect wage growth, so we should
not tighten monetary policy if that’s what the Fed believes
should be done. We think that this job-to-job quit rate
should be a central indicator to monetary policy because it
predicts wage growth better than employment itself.
The job ladder mechanism that you describe and model
in your paper, does it work well? Is it performing a social

function? Is there any reason to believe that it’s not
performing as it might in an ideal situation?
There are several different reasons why the pace of reallocation may not be ideal. Again, on average, people gain from
upgrading. They’re moving to more productive firms, so it’s
socially desirable to promote the job ladder. In that sense, it’s
probably not a good idea to prevent large firms from poaching workers from small firms. What we might want to think
about is helping small firms hire the unemployed because
high-paying jobs are in high demand by the unemployed and
employed. It’s hard for an unemployed to get a high-wage
job, because the employed are competing for that. There’s a
lot of congestion.

The paper’s main takeaways, according
to Moscarini:
• The behavior of firms of different sizes is very
important to understand what’s going on. We
don’t want to look only at aggregate employment.
We want to look at which kind of firms are hiring.
• It is not always small firms that suffer in recession.
• This last time was unusual. Small firms did suffer
more, and I think we have been paying the price
all along in the last five years because it made it
harder for people to get back into employment.
Hopefully, we are now at the turning point where
large firms will hire and wages will rise.

And so although these low-paying jobs are not as high paying as the other ones, they do let the unemployed back into
the labor force. And so it may be a good idea not to interfere
with the upgrading, with the quits, but if there’s any reason
why the job flows are too slow and the job recovery is slow,
there may be reasons to subsidize hiring of the unemployed
by small firms and that creates the opportunity for workers
to upgrade.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

Professor of Economics, University of Chicago
Paper: “The New Full-Time Employment Taxes”

Tell us what the paper’s about. What are the set of
questions you’re interested in addressing here?
I’m looking at the health reform or Affordable Care Act, as
it’s sometimes known. It has a number of taxes in there, but I
focus on the two that turn out to be the biggest, and I think,
often, the most underestimated or even overlooked. The first
would be the employer penalty, and that’s levied on large
employers that don’t offer coverage to their employees, starting next year and really going into full force in two years.
The second tax would be an implicit tax. It’s a benefit withheld from people because they are employed, and, therefore,
their employer’s offering them coverage. It involves the
withholding of some very generous assistance that came out
with the law, but it’s withheld, typically, from people when
they work.
And “large employers” are defined as…?
It’s a complicated definition, but roughly speaking, we could
say 50 employees and over.
So these are taxes that are implicit taxes, as you say, that
are overlooked by economists, policymakers? People
haven’t been talking about them very much?
The employer penalty has been given attention, but it’s been
well underestimated. Because of its tax treatment, it’s actually
quite a bit more expensive than the $2,000 headline number.
From a worker point of view, it’s expensive because it’s
anti-competitive. It really discourages employers from
having employees. Employee’s wages are going to suffer from
that, more than you would think from a more typical tax of
that size.


Let’s go back to the size of the penalty, which many
people say is $2,000, the headline. And through your
investigation, what do you find? To what extent has it been
underestimated? Is it significant?
It’s been underestimated in two ways. First of all, a lot of
estimates put the number of workers that are really affected
by it around 10-15 percent. I’d say it’s more like 25 percent.
The reason is this anti-competitive aspect to it that employers are discouraged from becoming large. That hurts even
employees who work for a small company, because their
employer is no longer willing to compete so hard for employees. So that would be one way it’s underestimated.
Then the tax treatment: Because salaries are a deductible
expense and penalties aren’t, employers really have to cut
salaries by over $3,000 in order to have that $2,000 to pay
the penalty. Also, it’s not a $2,000 penalty. It’s indexed to
health costs, and health costs have already gone up, so that’s
going to creep up on us as well.
I think you mentioned earlier that these are averages that
you’re reporting to me right now, but that there’s quite
a bit of heterogeneity that will impact various groups
differently. Is that correct?
Yes. It varies across people for a number of reasons, such as
their employer tax situation. Some people don’t work for a
for-profit employer, or their employer may have a different
rate depending on the state they work in. That’s a source.
If you think of the penalty in terms of the number of hours
that somebody has to work to create the value to justify the
penalty, that number varies. Some workers need to work a
lot of hours to create a little bit of value, and other workers
create a lot of value in a short amount of time. So, that’s
another major difference.

Do you actually try to quantify those? How do you do it?
And what do you find?
I look at the amount of the penalty, making these adjustments for taxes that I mentioned. Then I ask the question,
worker by worker, “How many hours do you have to work to
create that kind of value?”
So, a minimum-wage worker, for example, would have to
work a day every week of the year in order to create the value
that would pay for that penalty that his employer is going
to owe for him. One day a week for the government, on top
of all the other days of the week we normally work for the
government, is a lot.
This paper is not one where you investigate the likely
behavioral consequences of this distorted tax—implicit or
otherwise—from the Affordable Care Act. Do you intend
to investigate it further?
I have a book. The front part of the book measures the taxes
in many of the same ways as in the paper, and the second
half of the book looks at the behavioral consequences.
In the system that existed before, you could argue there’s
quite a bit of cross-subsidization, in that employees
at full-time establishments pay higher premiums to
cross-subsidize the uninsured. Presumably, that crosssubsidization will go down if it’s replaced by this ACA. Is
this counted as part of the taxes? Are you measuring net
The paper I had today doesn’t deal with those taxes. The
paper I had today only deals with two of the big ones. There
are other ones that aren’t as big, and some of them go in the
other direction. Maybe you’re alluding to some of those. In
the book, I cover them all.
We’re hoping we’re going to have, say, less uncompensated
care. And that would have the effect of a tax cut. But it’s not
that big. Uncompensated care in the nation is $50 billion
a year or less. These taxes are getting up in the hundreds of
billions, so they’re a different order of magnitude. But you
have to account for it. If you want to get an accurate answer,
you need to account for uncompensated care. And I do.

So you’ve written a book. You’ve studied the U.S. health
care system, insurance system, in detail. Do you make
cross-country comparisons? From what you’ve discovered
in your investigation, do you think that there are superior
ways to deliver the same product? Or is the ACA messing
up along some dimensions?
It’s not quite my expertise. Actually, the title of my book
is adopted from Keynes. Keynes wrote The Economic
Consequences of the Peace, and I wrote The Economic
Consequences of the Health Reform.
One thing we have in common: We were saying, “Look,
we have a document presented to us. What is its impact?”
And we don’t address what Keynes called the ideal question:
What would have been a better document? I don’t know. I
don’t have a better document. I have the document I have,
and here are its effects. People should address that, but first
thing I think would be good to understand is: The document
we were given, what is it going to do to us?
So, let’s first understand what the likely effects are of
the legislation as it’s passed, and then subsequently, we
can debate the merits and the pitfalls and talk about
alternative design. That’s your view.
I took that off of Keynes’ playbook.

The paper’s main takeaways, according
to Mulligan:
• I think a Fed audience is interested in two numbers that I come up with: that employment will be
3 percent less—because of the law and all its taxes,
especially the two that were emphasized in the
paper—and GDP will be about 2 percent less.
• Both of these impacts will be forever or however
long the law lasts, and most of that, again, comes
from the two taxes in the paper that we talked
about in the conference.

To watch the interviews from the conference, visit
To access the papers that were presented, visit


Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

William R. Berkley Term Professor of Economics, New York University
Paper: “What Shifts the Beveridge Curve? Recruitment Effort and
Financial Shocks”
(with Alessandro Gavazza and Simon Mongey)

Why don’t you start off by explaining to people what the
Beveridge curve is and why anybody should care about it?
The Beveridge curve is the empirical relationship between
the unemployment rate and the vacancy rate. The unemployment rate is the fraction of individuals in the labor force who
look for jobs, and the vacancy rate is, loosely speaking, the
fraction of idle positions or open positions in the economy.
Obviously in an ideal world, in a world without frictions
and in our perfectly competitive models, both the vacancy
rate and the unemployment rate are zero, because of market
clearing in the labor market.
In the data, it is not the case, and in a large class of frictional labor market models, this is not the case, meaning
that unemployment and vacancies coexist in equilibrium.
Typically in the data, there is a negative correlation between
unemployment and vacancies. For example, in an expansion,
firms post more vacancies, so the vacancy rate goes up, and
workers find jobs at a faster rate, so the unemployment rate
goes down. This generates a negative correlation over the
business cycle between unemployment and vacancies.
As a consequence, typically, the Beveridge curve, this empirical relationship, is negatively sloped. Now, in the data every
once in a while, this correlation changes sign and becomes
positive. For short periods, or long periods depending on
the country we look at, unemployment and vacancies are
positively correlated. This means that we see in the data
simultaneous increase in the unemployment rate and in the
vacancy rate. This is a sign that there is a deterioration in the
way the labor market works, because the fundamental role of
the labor market is that of putting together idle jobs and idle
workers. If they both increase at the same time, it means that
there is a decline in what economists call aggregate matching
efficiency, or the effectiveness of the labor market in combining job seekers and idle positions.
After the Great Recession, we did observe one especially
significant instance of positive movement between unemployment and vacancies, or in other words, an outward shift
in the Beveridge curve. For example, before the recession,
an unemployment rate of around 7 percent was associated

with a vacancy rate of, say, 2 percent. After the recession, the
same unemployment rate of 7 percent was associated with
a vacancy rate of almost 3 percent, so more unemployment
and more vacancies that coexist in the labor market.
Is it a common phenomenon during recessions for this
Beveridge curve to shift or for this efficiency of the
matching process to deteriorate? Or is it something that’s
kind of special with respect to the last recession?
The quality of the data before, say, 2001 is not as good as
after 2001, so it’s difficult to make a historical statement
about this. If you compare the 2001 recession with the 2008
recession, for which you have high-quality data and comparable data, then in the Great Recession there was a remarkably large shift in the Beveridge curve.
What is the set of questions you’re interested in pursuing
in light of the facts of what the Beveridge curve is and how
it’s behaved?
In this paper, we are trying to understand the sources of
this observed shift in the Beveridge curve or this decline in
aggregate matching efficiency. We have in mind a mechanism that is based on an interaction between recruiting
intensity on the firm side and financial shocks. The idea is
very simple. The mechanism is based on three observations.
The first observation is that the job-filling rate—meaning
the rate at which firms fill vacancies—increases with the
firm’s growth rate. In the data, the firms that grow fast are
the ones that recruit with the highest intensity or the ones
that post their vacancies and spend a lot of resources—
advertisement, networking, screening, and so on—in order
to get quickly the workers they need.
The second fact is that it’s the young firms that have the
highest growth rate and contribute disproportionately to job
creation. For example, 20 percent of total job creation is due
just to startups, and almost half of job creation is concentrated in firms that are younger than 7 or 8 years old. So

The Great Recession has been characterized by a financial
shock, and this financial shock had a disproportionate effect
on young firms. To give you an example, we know that housing equity has fallen dramatically in the Great Recession.
Housing equity is a key source of financing for startups, so
young entrepreneurs often take a second mortgage on their
house in order to finance the startup, at the birth of their
enterprise. The inability of exploiting this important source
of financing in the Great Recession, has reduced the ability
to create new young firms, and those are the firms that
recruit with the highest intensity.
So how does that translate into a fall in matching efficiency
or a shift in the Beveridge curve? Basically what it means
is that even if we do see a lot of vacancies in the data, these
vacancies are not associated with a high recruiting intensity.
Firms post a lot of vacancies, but they don’t recruit with high
effort. And so it’s possible that we see high vacancy rate and
high unemployment rate because the employers are not really
looking hard for the workers.

Job Openings: Total Nonfarm, Civilian
Unemployment Rate 2000-12 2014-11



much of the job creation is in the young firms, and these are
the firms that grow the fastest and have the highest degree of
recruiting intensity.












NOTE: The job openings rate is shown on the vertical axis, the unemployment rate is shown on the horizontal axis, and the chart covers the period
December 2000 through November 2014.

can explain at most, I would say, between one-quarter and
one-third of the drop in aggregate matching efficiency. So
there is scope for other explanations, and this is one of the
reasons why we started working on this paper.

This is one interpretation of the so-called shift in the
Beveridge curve. I suppose there are other interpretations
as well. How does yours compare with, say, some
prominent explanations? And what are the key strengths
of yours versus these more conventional explanations?

There are a lot of people working on this issue: the
Beveridge curve, why it’s moving around, how to interpret
it. What motivates your research in terms of what
potential policy lessons might come out of this? Do you
think your research might at some point bear on some
labor market policies?

Another prominent or certainly plausible explanation of the
shift in the Beveridge curve is an increase in occupational
and geographical mismatch between unemployment and
vacancies. The recession hit mostly the construction sector
and manufacturing sector, and there were other sectors like,
for example, health care that actually kept growing. After
the recession, what happens is that you have a lot of workers
that are fired from the construction and manufacturing sectors, but the available vacancies are in different sectors. That
means that there is a misallocation or mismatch between
unemployment and vacancies and that can, again, contribute
to this coexistence of a high vacancy rate and a high unemployment rate.

Certainly, but we are still at a very preliminary stage of the
project, so I want to be very cautious in terms of possible
policy recommendations. The reason why what we do is
interesting from a policy perspective is that there has been a
great emphasis, I think, and for the right reasons, in trying
to understand what the effect of the generous extension of
unemployment benefits was on the unemployed workers’
search effort. There was a lot of focus on the job seeker side
with the idea that if we’re extending unemployment benefits
for too long, if the unemployment benefits are too generous,
there is a disincentive effect on the unemployed and that can
actually prolong the recession.

So basically a structural disturbance that makes matching
across sectors more difficult than within a sector. What
would be wrong with that interpretation? Would it be
complementary with your interpretation?
Exactly. I worked on the measurement of mismatch in a
separate paper, and we did conclude that that mechanism

We’re shifting the focus a little bit towards the firms,
essentially. We’re saying it’s possible that it’s actually the
firms that are reducing their recruiting intensity, their search
effort, and the reason is that this recession has been especially detrimental for young firms. If you want a fast recovery, one possible policy prescription, with all the caveats,
would be to try to actually foster job creation.
Fostering job creation—which is another point that I
think John Haltiwanger makes very clearly in a number of

Connecting Policy with Frontier Research: Economist Interviews from the 39th Annual Federal Reserve Bank of St. Louis Fall Conference

academic and policy pieces—doesn’t mean helping small
firms, because there’s a big distinction between young firms
and small firms. There are a lot of small firms that are not
young that don’t have any growth potential. I think about
the drug stores around the corner. They are at their optimal
size. It’s not like they need to grow further. But there are
many young firms that are small and at the same time have
significant growth potential, and those are the ones that
need to be targeted if they are suffering because of disruption
in the financial system that is supposed to channel resources
towards them.
Of course, doing it right is very hard because we know
there are many young firms that start well and then close
shop after a few months because things go wrong. So it’s
extremely challenging to target, even among the young
firms, those that have growth potential, and that’s really an
important challenge for policy.
The challenge I guess would be for policy to actually
identify them. There are a lot of people and firms that
would like credit extension, a public credit policy or even
wage subsidy I suppose could potentially work.
Yes, or hiring subsidies. Exploring the impact of these policies in the context of our model is on our research agenda.

Your paper would speak to more of a direct credit market
intervention, I suppose. These are financial frictions that
are holding them back.
Yes. One of the conclusions of our paper is that these financial frictions were especially sharp in the recession, and so
easing that friction would have helped. But once again, this
conclusion is preliminary.

The paper’s main takeaways, according
to Violante:
• What we hope to learn is whether the recruiting
intensity channel, or the search intensity on the
firm side, can play an important role in business
cycle fluctuations.
• This is something that has not been emphasized
enough in our view with one notable exception, which is the paper by Steven Davis, John
Haltiwanger and Jason Faberman that inspired
our work.

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